In early 2009, a cryptocurrency (digital currency) known as Bitcoin was launched and, since then, it has been leading a significant revolution in virtual currency. The main ingredient of Bitcoin’s success is a system of recording or storing information that makes it almost impossible to hack or change for a long time: blockchain technology.
In short, the blockchain technology itself is a securest database that makes it difficult to cheat the system. What makes it so important is that this is not a conventional database: the system works like a logbook (digital ledger) but is inviolable, “unbreakable,” and quite efficient.
The technology is so interesting that it soon became clear that the Blockchain could also be used in other systems of the most diverse types: financial, commercial, government, managerial, electoral, and any system where we need to store or perform securest transactions. There is no doubt that financial banks, insurance companies, forex or stockbrokers, security companies, government departments, and many other institutions are being attracted by this latest and secure technology.
In this Guide, I will try to answer your questions:
- How does the blockchain work?
- Why does the Blockchain have so many advantages?
- Why is the Blockchain so revolutionary?
Moreover, if you have questions about anything, don’t worry: I will answer all your questions in the comment section below.
In this article, you will learn:
- What is Bitcoin?
- How to get Bitcoins?
- What is the meaning of Blockchain
- What is “Block” in a Blockchain?
- How does Blockchain work?
- What are the types of Blockchain
- What are the Blockchain Consensus Protocols?
- Advantages of Blockchain Technology
- Blockchain Applications – Examples
- Disadvantages of Blockchain Technology
What is Bitcoin or BTC?
Before we start our foray into the blockchain universe, it’s worth understanding what Bitcoin (a short form of BTC) is. By doing this, it becomes easier to understand the importance and functionality of the Blockchain.
Well, as I discussed earlier, Bitcoin officially appeared in early 2009 — on January 3rd, to be exact. Months earlier, in 2008, an article by Satoshi Nakamoto was released in discussion groups describing the concept of BTC.
“Satoshi Nakamoto” is a pseudonym representing a person or a group of individuals who invented this technology, and his identity is still a mystery. Over the past few years, a few names have come up claiming they are the creators of BTC, but to this day, it’s not clear who this person (or this group) is.
But what we need to understand here is that Bitcoin is a fully digital currency (no paper currency) with a global reach and not controlled by any traditional institutes, governments, or any other governing authority. However, there is no central bank, which means there is no middle man who charges a fee or commission from both sides, and it is used to transfer funds privately.
We are talking about a currency — a system, in fact — with a distributed method (without any middleman) and self-regulated. Everything is based on secure and encrypted digital transactions, which is why Bitcoin is considered a type of cryptocurrency that uses cryptography techniques to be securer.
And how much a Bitcoin has worth? It depends on demand and supply like all other products or services. Generally, more transactions are made at a given time period, and Bitcoin will be more expensive. At the time I was writing this article, a single Bitcoin cost over $49,304. Prices can vary significantly from minutes to minutes, even seconds.
How to get Bitcoins?
There are three ways:
– You can go to an online Bitcoin broker, also known as a cryptocurrency exchange that works as a kind of middle man or BTC seller. You can buy Bitcoin with USD dollars, Euros, and a lot of many other local currencies.
– You can accept Bitcoins as a form of payment method and for any sale or service provided;
– You can “mine Bitcoins,” but keep in mind, resort to a system that uses the processing power of one or more computers to solve complex mathematical problems (discussed later) to be rewarded with Bitcoins. Keep in mind and it is not easy to earn Bitcoins this way.
However, you can use your Bitcoins for your daily life transactions the same as you use “real money” or paper currency, including using fractions of the coin. Bitcoins must be stored in a Bitcoin wallet that is a system that allows you to make transactions and control your earnings.
You may see multiple types of BTC wallets, and each is associated with a private cryptographic key and a public key so that you can carry out operations. A solid encryption system is used to secure the Bitcoin so that no one can break its security: any change, no matter how small, invalidates the keys.
You will probably think about how a digital currency can have and generate value if there is no central command? It turns out that Bitcoin is a Peer-to-Peer (P2P) network, meaning that the transactions are managed by each of the nodes (users) that are part of the system — it’s something like “unity is strength.”
When you make a BTC transaction, the computer (or computing device) that you use for this purpose becomes part of the network through your Bitcoin wallet. If one node leaves this network for any reason, the others continue to keep the system running. However, if there were a central control, it would be sufficient for it to be overthrown for the system to fall to everyone.
So, if you think that how is Bitcoin distribution done without a centralized system? How are transactions carried out and validated? This is where the Blockchain comes into action, a public registry that gathers all the information necessary for processing and protecting transactions.
As I have already discussed, it is not just a record system. However, to understand, you have to explore the Blockchain.
Blockchain: A Distributed Registration System
Suppose you are part of a group of 100 people who end up on an island that does not appear on the map due to a strange plane accident. You are not in contact with the rest of the world, and there is no means of transport to get you out of there. You will probably be there for a long time, so you decide to set up a partnership on this island.
But you know from experience (and this story of a plane crashing on a lost island) that society needs true leaders. However, a governance structure generates power struggles that can turn into serious conflicts. So, you decide to design a different model of society: everything that happens needs to be approved by the whole group so that what is valid for one will have to be true for the others.
And how should it be done? From a logbook, someone brought on the plane. He explained that this book is magic: it can create infinite copies of them, but everything registered will automatically be registered in the others.
So, the copies will be the same forever. Due to this feature, you decide to create a copy of the book for each person. Since this book or copy of content cannot be erased with, it becomes an crucial part of a system that distributes resources honestly and efficiently on the island. Everything recorded in the book is valid for everyone, as the records appear in all units.
This book came to be called a blockchain.
What are the meanings of Blockchain?
Let’s get back to the “real world” (because I have shared the story for better understanding). You have such a society discussed in the island example as the Bitcoin platform and the magic book as is the Blockchain. The critical difference between them is that the real Blockchain isn’t magic: it’s a sophisticated computer system.
Since I am talking about a distributed database system with no middlemen, we need a reliable mechanism to allow direct financial transactions known as peer-to-peer. This is a crucial role of the Blockchain.
The Blockchain is a system is a register or record that stores all transactions processed on the system. In easy wording, Blockchain comes from two words, “block” and “chain,” which means a chain of blocks. A chain of blocks is nothing more than a set of registered information linked to previous and successor data blocks.
These blocks of information are also public because all participants (nodes) in the network have access. However, when it processed, blocks cannot be deleted, altered or changed. Furthermore, new registrations can only be made through a validation process.
This system is based on thousands of computational machines and it is distributed. When a (legitimate) update is made, all copies are synchronized in a matter of seconds. It is possible that a one or many systems disappears from the network, but this will not affect the system, as all the other nodes are still there.
The Blockchain has a mechanism called proof of work — indirect translation to certify the information in a chain of blocks and prevent fraud. It is a cryptographic protocol that validates a transaction on a computer (or another device) by solving a mathematical problem.
Tampering with blockchains, however small, will yield different results than expected for this mathematical problem. This prevents the transaction from being processed and, consequently, its registration. We will study this aspect in more detail later.
What is “Block” in a Blockchain?
Every block includes the following components:
- Hash of the block
- Hash of the previous block
Remember, the data is recorded in a block based on the blockchain type: for example, BTC blockchain stores the transaction details such as receiver, sender, and number of cryptocurrency coins. Hash is similar to the human finger that is always unique, and it is used to identify a block and its content. It is generated when a block gets created and changes its value with every change in the block. So, it is the main reason why it helps to detect the changes made to blocks.
How does the blockchain work?
This distributed-structure blockchain scheme is what makes Bitcoin (and eventually other cryptocurrencies) so reliable. To better understand how this works, let’s look at the elements that make up the system, starting with the blocks.
You already know that blocks contain the records themselves. All confirmed transactions — such as the transfer of Bitcoin amount from one computer to another — must be recorded in them. New transactions generate new records, which, as such, must be inserted into new blocks.
In Bitcoin, by default, a block is closed containing all transactions in that period every ten minutes. I must emphasize that this time interval can be different at other times and on other systems that use Blockchain.
In addition to the set of transactions, a block must have a code that links it to previous block (after all, they are connected in a chain) and the code that connects it to next block.
We have a chain for three blocks; each has its hash and previous hash.
- Hash: 3W8F
- Previous Block Hash: 0000
- Hash: 2BR1
- Previous Block Hash: 3W8F
- Hash: 9G4S
- Previous Block Hash: 2BR1
Here, we can see that block3 points to block2 and block2 points to block1. You can see, block1 has a unique value, and its previous hash value is 0000, and it can never point back if it is the first block in the chain.
But how to generate these blocks securely, without connections being changed to direct to an illegitimate block, for example? Here, the primary weapon of the system is the figure of the miner (or miner).
Remember when I said that one of the ways to earn Bitcoin is by mining? The complex problems that miners have to solve concern the creation of new blocks and, in effect, the validation of transactions.
A miner is nothing more than a computer (or a set of machines acting as one) that uses specific software to perform the calculations. Whenever the process is completed, the miner is rewarded — here, with Bitcoins.
It works like this: the software analyzes all the information referring to the block and applies a specific mathematical formula to that dataset. The result of the calculation done with this formula is a code called a hash. Typically, this code uses a hexadecimal base, which, in practical terms, makes it consist of letters and numbers.
Each dataset is unique, so every time this mathematical formula is applied to the block, the generated hash code will be the same. But if the dataset undergoes any modification, the hash code will be different no matter how small. Then you can’t go any further.
In addition to its hash, the block contains the hash of the previous block. This way, a verification process will notice when a block is not legitimate, as its hash code will be different from the registered ones.
As you already know, Bitcoin is a network. Each member of the network is a node. So, if you have a computer with software to transact with Bitcoins, that machine ends up being a node.
This software maintains and helps distribute real-time, up-to-date copies of the Blockchain in use. Every time transactions are performed, and therefore blocks are added, all nodes are communicated so that they can update the records with the new information.
The encrypted communication mechanism (remember, that method of private and public keys) prevents this network from being hacked or nodes from being inadvertently added.
Also, take into account that nodes participate in the validation of transactions. A series of procedures are applied to verify if there is a consensus on carrying out a given transaction. So, if you are receiving Bitcoins from someone as a form of payment, a verification process with us will confirm the transaction.
The above discussed transaction will be recorded on the Blockchain. As this record cannot be deleted, in theory, no one can take these Bitcoins from you by making changes to the blocks.
What are the types of Blockchain?
Blockchain has three types:
- Public Blockchain
- Private Blockchain
- Consortium Blockchain
Let’s understand them quickly.
In this type of Blockchain, any user can be associated with the blockchain network. Moreover, data stored on this Blockchain network is accessible to everyone worldwide; anyone can have the right to read and write data.
As the name indicates, a public blockchain is completely decentralized solution as the permissions to write and read data are shared by all users equally who reach an agreement before data gets saved on the Blockchain.
In this type of Blockchain, only one organization or authority can control the permissions to send, write or/and receive data.
These blockchains are based on few users who can access and perform transactions on the blockchain network.
Organizations owning this blockchain control and change the rules or cancel transactions based on the deployed regulations.
It is also known as the permissioned blockchain network, a hybrid model between a highly-trusted private blockchain entity model and low trust offered by a public blockchain.
A few selected users are allowed in a consortium blockchain instead of enabling any user to participate in the transaction validation process.
What are the Names of Blockchain Protocols?
Many blockchain protocols exist, but few of the platforms use their own defined consensus protocols to validate the transaction. Following are the most commonly used blockchain protocols:
- Proof of Work (PoW)
- Proof of Stake (PoS)
- Delegated Proof of Stake (DPoS)
- Proof of Authority
- Leader Based Consensus
- Economy Based Consensus
- Voting Based Consensus
- Virtual Voting Consensus
Advantages of the Blockchain
You may already be able to imagine and understand the solid reasons behind Blockchain to find space in applications other than Bitcoin. But let’s see some. We can start with security.
The blockchain structure makes the Blockchain virtually inviolable. To successfully tamper with something valuable, the attacker have to control more than 50% of the nodes to make changes by consensus that is impossible.
In the Bitcoin universe, at least, this massive control of nodes would require immense computational power. It is unfeasible, therefore. Changing a record would require rewriting the entire database virtually. Again, it is unfeasible and impractical, but you cannot say impossible.
Availability is another significant advantage. The distributed structure makes the current system to continue functioning even if one or many nodes go down. When missing nodes come back to the network, they are immediately updated.
Let’s also think about reliability. As you know the data on the Blockchain cannot be deleted or altered, so everyone is confident that all the transactions recorded there are legitimate and healthy.
Another aspect to consider in the Blockchain is transparency. Transactions are public, meaning that all nodes can check them. Encryption mechanisms are the systems that are used to make sure so that system users can note be identified; however, it is perfectly possible to bind identities if necessary — this aspect helps ensure that only legitimate users participate in the transaction.
Operating costs can also be lower compared to centralized computing systems. , in general, the distributed model implies sharing of processing. This aspect varies according to the application but and storage resources.
Blockchain Applications — Examples
We already know that the Blockchain is a fundamental part of Bitcoin, but we also understand that the concept can be used in other applications. Okay, but which ones? Let’s go to some examples.
There are a growing number of banks and finance companies taking an interest in the Blockchain. The industry has already realized, for example, that the technology can be used for payment transactions and money transfers. Please note that international transactions can take few hours to complete. Blockchain can make the process faster and, at the same time, provide more security.
As the data cannot be erased or tampered with, government systems can use the Blockchain to combat the embezzlement of public resources, facilitate auditing processes, and prevent fraud in elections.
Fight against money laundering.
All over the world, governments and companies in the financial sector are increasingly taking steps to combat money laundering. Because it is immutable, the Blockchain can serve as a basis for these measures — including the use of identity verification systems, transaction checks, and detection of suspicious movement of resources, for example — to become more reliable and challenging to be circumvented.
Registering users or customers in a blockchain system can combat identity spoofing, which would be helpful, for example, for closing electronic contracts or transferring ownership.
The use of the Blockchain technology is also being considered valuable for patent and copyright management. By associating work with a person, the system could, for example, help a company to check whether a specific individual is the author of the content he is offering.
As the Blockchain is a distributed database, it is also possible to use the technology to distribute system documentation, user manuals, academic articles, digital books, and the like. The Blockchain can be used to share virtually any type of information.
The Blockchain has been particularly relevant to a type of application gaining momentum: intelligent contracts (smart contracts). In this modality, the software creates contracts with specific terms and conditions according to the circumstances.
Consider, for example, a virtual store that uses different delivery services to serve customers across the country. For a closer customer, the system can consider the shorter distance to draw up a contract with a quick delivery time. For customers who are further away, this same system can include in the longer-term contract and the collection of any local tax, all automatically.
The Blockchain can help this type of software perform checks and register transactions that, among other benefits, will prevent the company from slipping in one or more clauses and suffering losses.
Despite providing a number of advantages, it is not sensible to treat the Blockchain as a magic solution, capable of solving everything that is computationally challenging. This is because such a system can have “side effects.”
One of them may be the requirement of a large processing capacity or a network capable of handling large volumes of data. As the Blockchain involves cryptographic procedures, a system that is heavily accessed or with many nodes has a high chance of presenting overload.
To keep the system running smoothly, it may be necessary to spend considerable sums on computers that support operations or network equipment capable of handling heavy data traffic.
Furthermore, depending on how the Blockchain is structured, the response time of specific operations can be long, a situation that tends to cause considerable bottlenecks if the demand for using the system increases.
Remember, as time passes, the Blockchain can end up becoming “bloated” and, proportionally, slower.
Based on the application, the overall operating cost of the Blockchain can also be expensive. There are many factors including development, training, safety, and maintenance can make a solution of the type impracticable if not carefully measured.
That’s why the development and deployment of a blockchain-based system need to be well planned. Several scenarios must be considered to prevent bottlenecks, reduced efficiency, or even security issues.
Therefore, a thorough study must be carried out to assess whether the Blockchain is a good solution for a given application. How and under what circumstances it may be required to increase the system’s capacity? what actions should be taken to prevent the technology from failing regulations or laws, such as ensuring that there are no outages, etc.
The mentioned applications are just examples to give you an idea and a clear picture. There is a massive possibility that blockchain technology can be used for individual users, businesses of all sizes, governments, and other institutions.
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The subject is relatively new, so ideas around the concept are just beginning to emerge. But, as you may have noticed throughout the text, the blockchain proposal has enormous potential and can benefit the most different fields of activity.
Blockchain characteristics can indeed be disadvantageous for specific applications, for example, services that, in respect of privacy laws, need to allow users to erase their data — blockchain immutability is a barrier to this need.
Also, in a private system (such as a company’s internal network), all nodes can be controlled at once because the administration of these machines is often centralized. If there is no effective means of protection, an attacker could take over the nodes to permanently modify the Blockchain.
As you can see, the advantages and disadvantages of the Blockchain need to be evaluated in each case. A technology use scenario cannot be envisioned just because of the hype surrounding the subject.